More National Income Accounting

GDP data are important by themselves. However, by
deriving a series of other measurements, one can compute how
much of GDP is left as spendable income in the private and
government sectors, which allows one to construct a "budget
constraint" for the economy as a whole.

To get from National Income to
Disposable Income (DI), which is the income that
people can either spend or save, a number of adjustments
must be made. First, that part of corporate profits that
never reaches households, retained earnings and corporate
taxes, must be deducted. Next, adjustments must be made in
interest so that it includes only and all interest payments
reaching households. Then, payments to the government for
social security and related programs must be subtracted, and
transfer payments from the government for these programs and
other programs must be included. Finally, business transfer
payments, which include donations to non-profit
organizations and the write-off of bad debt, are added. This
gives what is called Personal Income. Some of
Personal Income must be paid as taxes. What is left,
Disposable Income, is either spent or saved.

There is a point to all these computations. In deriving
disposable income from GDP, we separated amounts flowing to
households from the rest of GDP. In the process, we can see
where the rest goes. Some stays in the business sector as
business savings. Retained earnings and depreciation are
important parts of this sum. Some income ended up with the
government. The amount left in the government is the total
of taxes less all transfers. Finally, somewhat lost in the
numbers are some transactions involving foreigners. They pay
us interest, we pay them interest, and there are also
transfers in the form of aid. Let us call this total
"Foreign Transfers (Tf).

This separation allows us to write GDP in a way that
shows how much each sector (household, business, government,
and foreign) is left with:

(2) GDP = DI + Business savings + (Taxes - Transfers) +
Tf

Disposable income is either consumed (C) or saved (S). If
savings by households is combined with business savings to
get savings by the private sector (S), equation 2 can be
written:

(3) GDP = C + S + (Taxes - Transfers) + Tf

Since equations 1 and 3 are both
ways of arriving at GDP, we can combine them as:

(4) C + I + G + Xn = C + S + (Taxes - Transfers) + Tf

Reorganizing, and letting consumption cancel from both
sides, gives:

(5) (I - S) + (G + Transfers - Taxes) + (Xn - Tf) =
0.

Equation 5 is a constraint that the economy as a
whole faces. It may not mean a great deal to you when you
first look at it, but in fact it is an important equation.
Consider what the contents of each set of parentheses mean.
The first term tells us about the private sector. If
investment is greater than savings, the private sector must
borrow to finance the extra investment. If savings is
greater than investment, the private sector will lend to
other sectors.

The middle term, (G+Transfers-Taxes) is the government
deficit or surplus. Total government expenditures equal its
purchase of goods and services plus its transfers. If these
are larger than tax receipts, the government has a deficit,
and must borrow to cover it.

The last term indicates the borrowing or lending of
foreigners to finance foreign trade. When foreigners buy
from us, they must have a source of funds. One source is
selling to us. If they sell less than they buy, they must
borrow the difference from us. If we buy more from them than
we sell to them, we must borrow the difference from
them.

We have arrived at a simple result in a complex way. In
any market the purchases of buyers must equal the sales of
sellers. Equation 5 shows this for the market for loanable
funds. If someone borrows $100, then someone else must lend
$100. Equation 5 divides up all transactors in this market
into three groups, the private sector, the government, and
the foreign sector and says that not all sectors can borrow
at the same time. When one borrows, another must be lending.
Financial markets link the decisions of people who may have
no idea that their decisions are in fact connected.

The table below puts some numbers from the U.S. economy
into this equation. Notice how dramatically foreign
borrowing changed in just two years. In 1984 the United
States had a huge deficit in its balance of trade--it bought
much more from foreigners than it sold to them. The table
says that the dollars that foreigners earned on these sales
were returned to the U.S. government and businesses in the
form of foreign loans.

The U.S. Budget
Constraint

.

1982

1984

Investment - Savings

-109.1

-37.0

Government Deficit

115.3

122.9

Foreign Borrowing

-6.6

-93.4

Statistical Discrepancy

.5

7.5

Sources: Survey of Current Business, Nov.
1984, 1985. Amounts are in billions of dollars; a
negative represents lending to credit markets and a
positive represents borrowing. The "statistical
discrepancy" occurs because there are errors in
measuring the components.

It would be nice if the table could tell us why the large
amount of foreign lending to the U.S. suddenly occurred.
However, neither the table nor the equation on which it is
based can do that. They simply tell us that there are
connections among the sectors of the economy. If the
government sector runs a larger deficit, for example, other
sectors must finance the deficit and thus they will be
affected. Although the equation clearly shows that a change
in the government's deficit will affect other sectors, it
does not tell us what the effects will be. For this we need
economic theory, and in this we do not find consensus among
economists. On one hand, Keynesian economists (those who
draw inspiration from the writings of John Maynard Keynes)
have argued that an increased deficit may increase savings
by more than the increased deficit, and thus actually
increase investment. On the other hand, non-Keynesians have
usually argued that the increased deficit will have little
effect on savings and will crowd out investment. Explaining
these theories is the major task of a course in
macroeconomics.